Tuesday, December 6, 2011

White House: Lower Taxes By Raising Taxes

President Obama continues with the “country over party” and “fair share” campaign rhetoric, this time by claiming Republicans would rather “raise taxes on middle class Americans” than “ask a few hundred thousand millionaires and billionaires to pay their fair share.”

At issue is recent legislation proposed by Democrats that would provide workers and employers with continued relief from a substantial portion of payroll taxes, or more accurately, FICA taxes. Republican’s object to the legislation as it pays for itself, not by cutting spending, but by raising taxes on the wealthy (which includes small businesses). Democrats hope the extra cash in most everyone’s pocket helps stimulate demand and lifts the economy, and believes that the “rich” can afford to pay their “fair share.”

We’ve debunked the premise that Republican’s are somehow putting the interest of their party over the interest of the country. We’ve also debunked the idea that the “rich” are not paying their fair share. Yet these simple truths are lost on the President and Democrats in Congress. A cynic might say they fully understand the faulty logic of these arguments, but can’t resist the lazy political lay-up that class warfare provides leading up to the 2012 elections.

Mark us down as cynical.

Let’s start by reminding ourselves exactly what the “payroll tax” represents. The payroll tax is intended to be each employee’s down payment (matched by their employer) on their government run retirement savings plans (i.e. Social Security) and health care insurance plan (i.e. Medicare). Over an individuals working life, the payroll tax would be collected, invested and then returned to the individual in the form of Social Security checks and Medicare coverage after retirement.

A well managed organization would estimate the future costs of those programs and “charge” an amount to each worker that covers those future costs. It’s insurance 101 – collect premiums upfront, invest those premiums, and hope that the premiums paid, plus their appreciation over time, is greater than or equal to the costs to be incurred in the distant future.

However, as we are painfully aware, the government is not a well managed organization and these programs are suffering from a double-barreled death sentence.

First, the Government has either not hired actuaries, or has not listened to those actuaries, because the programs are incredibly underfunded (roughly $45 trillion) – i.e. the future cost of these entitlements far outweigh the future value of payroll taxes collected. The characterization of Social Security and Medicare as ponzi schemes is accurate – paying off promises to existing investors (retirees) with money from new investors (current workforce). When the scheme collapses, like they always do, the current workforce will lose, and lose big. For example, if you are 60 when the program collapses, you will have contributed 6.5% of your lifetime earnings into a program that is going to pay you zero in future benefits.

Zero. Zilch. Nada.

Hopefully you’ll still have parents around to scream at for letting this happen on their watch.

Second, despite being vastly underfunded, Congress still couldn’t resist the pull from a shining pot of cash and have raided the programs current surpluses (i.e. excess of cash on hand, not counting future obligations) to pay for other runaway government spending programs. So instead of cold hard cash surpluses to fund the near-term operations of the programs, these programs have piles of IOUs from the US Government.

Therefore, the payroll taxes paid by everyone today are being used to fund our parents and grandparents Social Security checks and Medicare benefits, because their payroll taxes were used to fund their parents and grandparents Social Security and Medicare benefits, as well as various other government spending programs. Without fundamental reforms, we’re doing the same to our children and grandchildren. There will come a day when the imbalance will be so significant that painful action will be demanded. Our children and grandchildren will suffer this pain and hardship, either in the form of substantially higher taxes or a reduction/elimination in the promised (and paid for) benefits. It’s shameful and pathetic.

So what’s the solution?

We’d prefer to eliminate payroll taxes and the programs they fund (i.e. Social Security and Medicare) and let individuals decide how to save for retirement and fund health care insurance in the open market. That’s politically impossible, so the more likely solution is to reform these entitlements to ensure that the “taxes” received are sufficient to fund the future promises made by Social Security and Medicare, and kept out of the reach of Congress. Hopefully this can be achieved through a reduction in the size of the benefit entitlements (i.e. higher retirement age, smaller Social Security checks, greater deductibles/contributions to health care, etc.), but if citizens demand these benefits and are happy to pay for them, then payroll taxes will need to be raised to properly fund these obligations. We can't continue to have our cake and eat it too.

Everyone, regardless of income level, receives Social Security and Medicare benefits, so everyone, regardless of income level, should pay for them. Payroll taxes are the last place we should be cutting, especially in an environment where 50% of workers are already exempt from funding government activity by paying zero or negative income tax.

For those worried about the “fairness” of this approach, keep in mind that paying a % of income rather than a flat amount makes this program highly progressive. The Social Security benefit is driven in large part by the amount of income earned, however, the benefit is calculated in a progressive fashion so that someone making $100,000/year, will receive less of their average monthly income (roughly 30%) than someone making $25,000/year (roughly 45%). The payroll tax only gets more progressive when the Medicare benefit is incorporated. Medicare coverage is worth the same amount to everyone, yet the amount paid for that coverage is dependent upon the amount of income earned.

The solutions are obvious, yet our elected officials refuse to stop playing around the edges and can’t summon the political courage to make tough decisions on our runaway entitlements. Everything else is just political games and grandstanding. We need more than a trillion dollars in savings today, not billions over the next 10 years. Populist sound bites about the “rich” and “socialism” may help win elections, but our country needs fresh ideas and bold actions.